The global economy has had some of the wind taken out of its sails. One illustration of this is the decline in the US ISM manufacturing index.
But there are no major causes for concern according to Robeco Chief Strategist Ronald Doeswijk as “the underlying movement is more favorable than one headline figure suggests”. It was mainly the inventory component of the ISM index which caused the fall, which means production can take off more quickly once demand gets into gear.
Furthermore improving labor and housing market data indicate ongoing recovery. The self-reinforcing economic recovery here means that the US is still Robeco´s favorite region for equities.
Europe – positive news is hard to find
What Ronald Doeswijk describes as the “most striking development in Euroland” is the weakening German economy, marked by a significant decline in producer confidence over the last few months. It is reasonably quiet on the periphery but unemployment is ticking up. A preference for structural reform over austerity measures and stays of execution when it comes to budget-deficit reduction are the order of the day. Therefore a new chapter in the debt crisis is even possible.
Central bankers keep reins loose
In both the US and Europe central banks are inclined towards more monetary easing. President Ben Bernanke of the Federal Reserve Bank has kept the doves happy by implying in his press conference that the door is still open for further easing. And in the Eurozone deflationary risks are likely to increase, according to Doeswijk. "Although we are not expecting this in the near term, additional easing may come in the form of a negative deposit rate". Last but not least the BoE will continue its efforts to stimulate lending to the real economy.
“Below-trend growth but positive developments in the US economy and increasing optimism about Japan”
Japan – light at the end of the tunnel?
While on the subject of monetary easing, it is important to figure out the effects of Abenomics. Has Abenomics given Japan a bit of its sparkle back? Perhaps. Japanese consumers seem to think so as their household spending jumped 5.2% in March reflecting new optimism also underscored by solid stock market gains. Before he can take a positive view on Japan, Doeswijk would like to see “more evidence of an economic rebound to support the stock price rises”.
Growth momentum slowing in Pacific
Elsewhere in the Pacific the growth momentum is slowing – here too inflation is stable or in a downward trend. Our view on the region is neutral.
Equities – defensive sectors outperformance set to continue
Equities are beneficiaries of the current low interest rate scenario. Corporate earnings are more or less flat and have given few surprises. Valuation remains neutral but the appetite for riskier asset classes is unlikely to wane until quantitative easing moderates – something unlikely to occur in 2013.
Defensive sectors have outperformed over one and three month periods. Their earnings revisions are also more favorable than their cyclical counterparts. According to Doeswijk and his team the relative performance of these stocks tends to be strong in the May-October period.
Real Estate – valuation is high but upside potential remains
Global REITs continue to perform strongly, rising 14% over the last three months. The current environment enables low cost refinancing and yields are attractive. The earnings outlook is more realistic than for equities but a “clearly negative factor” according to Doeswijk is valuation; Japanese REITs rose 48% in the first quarter (prices are now 50% above their NAV).
High yield and emerging market debt favored
The outlook for credits and high yield is positive. High Yield in particular offers decent absolute returns in the current low-interest-rate environment. Spreads for high yield are now close to those for the mostly investment grade local currency emerging market debt. Doeswijk is positive on both and summarizes the difference as a “trade-off between a lower rating (HY) and currency risk (EMD)”.
Commodities and government bonds are lagging in the search for yield
The outlook for commodities remains weak. Basic metal inventories are high and weaker economic activity in China and a faltering Eurozone have depressed oil prices. Geopolitical risks could cause upside surprises for oil. The outlook for gold remains bleak after its steep decline (prices fell 14.7% on April 15th) triggered by ongoing outflows from gold ETFs, lower physical demand and lower inflation expectations.
The current scenario of falling or low inflation, easier credit and moderate economic growth mean that there are few reasons to hold government bonds. Yields are too low to be tempting – there are more attractive, albeit riskier opportunities to generate returns elsewhere.